Vanguard Developed Markets Index Fund (VDMIX) tax distributions

Note: On February 4, 2014 the Vanguard Developed Market Index Fund (VDMIX) was merged into the Vanguard Tax-Managed International fund. This page documents historical data on the fund, which will drop out of the mutual fund data base.
The combined fund has been renamed Vanguard Developed Markets Index Fund and is available in five share classes. - Vanguard - Merger of international index funds complete, press release

The Vanguard Developed Market Index Fund was a suitable candidate for placement in taxable accounts. The table below summarizes the fund's relation to a number of tax factors.

The following tables provide long term data on the fund's history of both dividend and capital gains distributions. The first table also provides the historical distribution of qualified dividends and an estimate of the foreign tax credit.

The second table provides a database of the fund's accounting figures: the annual level of realized and distributed gains; its level of unrealized gains and loss carryforwards; as well as the annual in-kind redemption gains the fund has realized. These figures highlight the level of a fund's tax liabilities.

Because both manager turnover of securities inside the portfolio and investor turnover of fund shares can affect the level of gains realization, a third table provides historical turnover ratios.

Distributions

The Vanguard Developed Markets Stock Index Fund has a fiscal year ending in October, so its reported distributions for a year reflect the prior year's December distribution of dividends and capital gains.

The following table provides a view of the fund's historical distributions expressed in terms of yields. We can see that the fund distributed a very small short-term capital gain in both 2007 and 2008, but has distributed no other gains in its history. Approximately 75% of dividend distributions have been qualified dividends, which under the current tax regime, are taxed at lower capital gains tax rates.

FY 2013 - The fund changed benchmarks from the MSCI EAFE Index to the FTSE Developed ex North America Index on 04/16/2013.

Accounting data

The accounting figures and associated ratios (tables 3 and 4) can help one visualize some of the major determinants of a fund’s tendency to distribute taxable gains. These determining features include:

Turnover: The rate at which a fund manager sells securities within the fund has a major effect on potential gains realization. Single digit annual fund turnover percentages result in a low rate of realized gains. Similarly, fund shareholders' sales flows have major effects on a fund’s distribution tendencies. Net flows into the fund have the following effects:

Constant inflows allow a fund manager to purchase a wide range of price lots for shares. The manager can select high basis shares when forced to sell a stock (this may realize a loss). The manager can also select low basis shares when redeeming a stock in-kind (a non-taxable transaction that can remove an unrealized gain out of the portfolio.) Net inflows mean that shareholders are not forcing the manager to liquidate assets (and realize gains or losses) in order to meet redemptions. Large outflows can force such liquidation.

A large and growing net asset base serves to diffuse any realized capital gains across a large base of shareholders and reduces the per share gain distribution. Large outflows have the opposite effect; any gains realized are spread across a smaller asset base and result in higher per share distributed gains. [9]

Table 3.

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Definition of terms

Net sales/redemptions

This statistic reveals whether investors are net buyers or sellers of the fund.

Realized gain/loss

A realized capital gain/loss is an increase (or decrease) in the value of a security that is "real" because the security has been sold by the portfolio manager. The capital gains/losses are "realized" by the fund, and any distributions to the shareholder as a result of realized gains (adjusted for any realized losses) are taxable during the tax year in which the security was sold. Realized losses can be used to offset realized gains in an attempt to reduce taxable gains. If realized losses are higher than realized gains, a fund can "carry forward" these excess losses to offset future gains. In-kind redemption gains are included as gains in this statistic. As these gains are not taxable, they must be deducted from the realized/gain tally to reflect the net gain/loss for the year. (see tax attributes for the net gain computation).

Distributed gains

A net realized gain will be distributed to shareholders as a capital gains distribution.

Unrealized gain/loss

An unrealized capital gain/loss (also called a "paper profit or loss") is an increase (or decrease) in the value of a security that isn't "real" because the security hasn't been sold. When a portfolio manager sells a security, however, the capital gains/losses become "realized" by the fund, and any realized gains (net of any losses) are taxable during the tax year in which the security was sold. Funds with low turnover rates, such as index funds, tend to have more unrealized gains than actively managed funds and are less likely to pass taxable gains on to investors. A fund's unrealized appreciation or depreciation figures are valuable because they can give an idea of whether a fund would need to distribute any gains if all of its securities were sold. Such information may help you determine your potential exposure to taxable distributions.

This statistic is volatile, and will increase or decrease depending on market returns.

Loss carryforward

Realized losses can be “carried forward”, over a set span of years, to offset any future net realized gains.

In-kind redemptions

Instead of selling securities, a portfolio manager may elect to distribute securities in-kind to redeeming shareholders. Unlike a sale, an in-kind transfer is not taxable. This technique is frequently used in the ETF creation/redemption process. For institutional redemptions, a portfolio manager can select low-basis securities to transfer (removing the embedded tax liability) from the portfolio.

Turnover

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Definition of terms

Average net assets

Average net assets are derived from NSAR reports from the EDGAR database.

Redemptions

The dollar amount of fund shares sold by shareholders.

Sales

The dollar amount of fund shares bought by shareholders.

Turnover

The rate at which the fund manager sells securities within the portfolio. The reciprocal of this number reflects the average holding period of the portfolio. Low turnover often results in low capital gains realization.

R/ANA

The redemptions/average net assets (R/ANA) ratio reflects how fund shareholders are turning over their holdings in the fund. It is analogous to the investment manager's turnover ratio.

R/S

The redemption/sales ratio (R/S) illustrates whether investors are net buyers or sellers of the fund. A ratio of less than 1 means that investors are net purchasers of the fund. A ratio more than one means investors are net sellers of the fund. The R/ANA and R/S ratios, viewed together, can signal market timing activity within a fund. For example a fund showing an R/ANA ratio of 400% and an R/S ratio of 1 (equal buys and sells) is likely being market timed by fund shareholders.

Tax rates

Mutual fund distributions will be taxed according to the tax laws governing the investment over the holding period of the investment, which are subject to change. The actual tax imposed will depend upon each individual's tax rate and the timing of purchases and sales. The federal tax rates applicable to mutual fund distributions and investor sales of securities for the period 2013 onward are outlined below. Keep in mind that investment income may also be subject to state and local taxation.

Short-term capital gains distributions are made from realized gains on securities held for one year or less. Short-term gains are taxed at ordinary income tax rates up to 39.6%. Mutual fund short-term gain distributions are included in a fund's ordinary dividend distribution; therefore, capital losses may not be subtracted from these distributions when computing taxes.

Long-term capital gains distributions are made from realized gains on securities held for more than one year. Long-term gains are taxed at 0% for taxpayers in the 10% and 15% tax brackets, at 15% for taxpayers in the 25%, 28%, 33%, and 35% tax brackets, and at 20% in the 39,6% tax bracket. They are reported on tax Schedule D along with any other capital gains, and can be reduced by capital losses.

Qualified dividends are the ordinary dividends [10] that are subject to the same tax rate that applies to long-term capital gains. They should be shown in box 1b of the Form 1099-DIV you receive.

When you sell at a loss you will either offset capital gains which would have otherwise been taxed at your capital gains rate or you will offset income (up to $3,000 maximum per year) which would have otherwise been taxed at your marginal income tax rate, or both. If you offset capital gains that would have otherwise not been taxed at all (because your capital gains tax rate is 0%) then this part of the tax loss harvest may be an outright loss.

The Affordable Care Act imposes a Medicare surcharge of 3.8% on all net investment income (NII) once the taxpayer's adjusted gross income exceeds $200,000 (single) or $250,000 (married); while this tax is not part of the income tax, it has the same effect on investors as a higher tax rate. The NII tax begins to apply to individuals falling in the 33% tax bracket. Thus the top effective marginal tax rate is 23.8% on qualified dividends and long-term gains, 43.4% on ordinary investment income.

In addition, there is a 3.8% Medicare tax rate on investment income in excess of an adjusted gross income of $200,000 ($250,000 for married filing jointly), and 0.9% on salary and self-employment income in excess of this level.

Tax analysis

The annual fund accounting figures show that the Vanguard Developed Index fund turnover ratio usually stays in single digits. The rise in turnover during fiscal years 2009 and 2010 was likely due to the fund's transformation over the period from a fund of funds into a fund directly holding securities The FTSE Developed ex North America Index, being a large and mid cap market index, can be expected to exhibit low turnover in future years. This low turnover can be attributed to the fact that stock migration out of the index can come in three dimensions:

An individual company grows smaller and migrates out of the FTSE Developed ex North America Index index into the Small FTSE Developed ex North America Index;

Merger and acquisition activity removes a stock from the index;

A developed market country is reclassified from its status as a developed market and is placed into an Emerging market index.

Shareholder turnover, revealed in the Redemptions/Average Net Assets (R/ANA) metric, shows that shareholders have historically turned over their holdings in the fund at 20%-30% annual rates, suggesting average holding periods of between four and five years.

The fund has received net inflows every year of its history except for FY 2008.

A look at realized net gains/losses shows that the fund realized net losses during the 2008-2009 bear market. These losses produced loss carryforwards. Low fund and shareholder turnover should help retain most of these carryforward losses as offsets to potential future gains.

The following table presents the federal tax cost on the fund's historical distributions (see second tab, table 6.) under the current tax regime (with dividends taxed at marginal rates and long term capital gains taxed at a maximum 20%). Keep in mind that distributions can also be subject to state and local taxation, with marginal rates ranging from 0% to 10.3% (an average 5% state tax rate will add an approximate 0.14% to the annual tax cost of holding the fund.) The average is based on the results from 2004-2013, the period comprising the qualified dividend tax regime. The 2004- 2013 average dividend yield is somewhat higher than the long term (2000 forward) fund average yield.

The table does not include the capital gains cost associated with selling the fund at a gain. [12]

The third tab in the table provides a tax cost comparison of the Developed Market fund with the Vanguard Tax-Managed International Fund. Both funds track the same EAFE index. The slightly higher tax efficiency of the tax-managed fund over the period is due mainly to its providing 100% qualifying dividends during the 2004-2010 tax regime.

Table 6.

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↑ Net investment income per share and the ratio of net investment income to average net assets include $.400 and 5.19%, respectively, of annual dividends received from Vanguard mutual funds in December 2008. Effective in June 2009, the fund’s equity investments are solely in common stocks.

A portion of your ordinary dividend may be nonqualified because it can include items like these:

Taxable interest. When a mutual fund receives taxable interest, the income gets paid out as a dividend. It's a dividend when it goes out of the mutual fund, but it wasn't a dividend when it came into the mutual fund, so it can't be a qualified dividend.

Nonqualified dividends. Your mutual fund may receive dividends that are nonqualified. For example, the mutual fund may sell shares just 35 days after buying them, but after receiving a dividend. The mutual fund has to hold the shares at least 61 days to have a qualified dividend. Any amount the mutual fund receives as a nonqualified dividend gets paid to you as a nonqualified dividend.

Short-term capital gain. When a mutual fund has a short-term capital gain, it pays this amount to the mutual fund shareholders as an ordinary dividend.

Holding mutual fund shares less than 61 days. You should also be aware that any dividend you receive on mutual fund shares held less than 61 days is a nonqualified dividend, even if the mutual fund reports that amount to you as a qualified dividend. You don't have to buy the shares 61 days before the dividend is paid, but the total amount of time you hold the shares (including time before and after the dividend) has to be at least 61 days.

Almost all of the dividends distributed by Equity REITS come in the form of non-qualified dividends. Non-qualified dividends are taxed at marginal income tax rates.

↑ This table indicates the additional cost for the capital-gains tax when you sell, assuming that you pay taxes on the distribution and reinvest the after-tax portion of the distribution; since it is a one-time cost, the effect is annualized. For example, if you hold an investment for 30 years and lose 10% to taxes when you sell, that is equivalent to losing 0.35% every year. Thus, if you sell the fund, your cost will be the sum of the Table 6 and Table 9 costs. However, you would not pay the Table 9 cost on any stock which you either leave to your heirs or donate to charity, and thus may not pay that cost on your full investment. In particular, you might estimate your total tax cost by using the low-return line in Table 9; if stock returns are high, you will have a large taxable account and will reduce the tax cost by taking longer to deplete it or by not spending it all during your lifetime.
Taxes are computed at a tax rate of 15% on long-term gains (except in the "rate rises to 20% column", which applies if that tax reduction is allowed to expire), and on qualified dividends (except in the "no QDI" column, which applies if the tax reduction on qualified dividends expires and the rate is 35%). The foreign tax credit is added to the dividend yield before computing taxes; for example, if a fund had $100 withheld in foreign taxes on dividends, and you pay $20 in taxes on the withheld dividends, you get a $100 credit for a net benefit of $80. Although not tabulated, keep in mind that investors in the lower tax brackets (15% or lower) pay lower federal tax rates on investment income for the period 2003 - 2013, and reap higher after-tax returns, outside of tax-exempt municipal bonds, in all asset classes.